Posted by Nolan Miller on Jun 2, 2011

It is unlikely that there will be a lot of blogs where I agree with Newt Gingrich because I see economic policy as one of weighing costs and benefits, which tends to avoid extreme positions of the sort that the former Speaker as well as his counterparts on the left tend to advocate. But, last week he came out against Paul Ryan’s plan to replace Medicare with a voucher system (you can call it premium support if you want, but it’s still a voucher system) as too great a change in the current system, saying “I am against Obamacare imposing radical change, and I would be against a conservative imposing radical change.” I have to say that I agree with Gingrich the moderate on this point.

The Ryan plan will replace the current Medicare system — where individuals go to virtually any provider they want, receive whatever treatment that provider chooses, and present the government with the bill – with one where seniors are given vouchers from the government to purchase health insurance plans from private insurers who will then manage individuals’ care in much the same way as HMOs manage care for younger people. (See a nice discussion of the Ryan plan from the Kaiser Family Foundation, here.) The insurance plans, Ryan argues, will have an incentive to reduce costs, since they are not paid for providing extra treatment, and to increase quality, since plans that provide higher quality will attract more customers. The virtues of the market will work to increase quality and decrease cost, and in order to reinforce that the value of the vouchers will be pegged to overall inflation rather than medical cost inflation. This will, by definition, slow the rate of growth of health care cost, or at least the portion of the bill that the government pays.

I agree with the sentiments expressed in the Ryan plan. Something has to be done to rein in cost, and promoting competition seems to be a good way to go. However, there are a lot of open questions about whether such a plan could really be implemented (just as there are with whether the insurance exchanges in the Patient Protection and Affordable Care Act could really be implemented). To begin, markets for insurance with a large proportion of high-risk people are problematic. Insurers will have an incentive to try to select only the best risks, leaving those at higher risk to face higher prices and lower quality plans. There are methods of addressing this through a process known as “risk adjustment,” where the government increases the size of the vouchers for sicker people. The problem, however, is that we just aren’t very good at predicting who will be high cost and who will be low. The “state of the art” in risk adjustment is not where it needs to be to make the Ryan plan work.

A second concern with the Ryan plan is that one of the benefits of the Medicare system is that it features lower administrative costs than private plans. By moving people from Medicare to private plans, the Ryan plan is actually expected to increase the overall cost of medical care. This is especially true of risk adjustment is incomplete and private insurers in the Medicare market compete to select and retain good risks as they do in the current market for younger customers. For those who are more worried about the size of government than the cost of health care, this may be a tradeoff worth making. But, it is unclear whether the Ryan plan will succeed in lowering the overall cost of health care. (To be fair, I’m not sure we have any idea how to do it.)

Fortunately, there is a middle way that can move us in the direction of the Ryan plan without relying on a market that doesn’t work and without pushing people into a private sector that may be inherently less efficient than traditional Medicare. The approach leverages Medicare Advantage, the current system where Medicare recipients have the option of choosing to receive health care from private insurers rather than participating in traditional Medicare. Like the Ryan plan, Medicare Advantage plans are paid a fixed amount for every person they enroll, giving them an incentive to keep cost low and quality high. However, unlike the Ryan plan, seniors always have the option to choose to participate in the traditional Medicare plan.

On the bright side, Medicare Advantage plans do a pretty good job of providing seniors with health care, often including benefits beyond those in traditional Medicare at little or no additional cost to seniors. On the other hand, due to a flawed system through which payments to Medicare Advantage plans are set by the government, the government currently pays on average more per enrollee in Medicare Advantage than that person would cost in traditional Medicare.

So, how do we save Medicare? Easy. First, fix the system that sets payments to Medicare Advantage plans. One mechanism that would help is to move to a competitive bidding system, where government payments to plans are based on the lowest bid by any qualifying plan. We might even restrict the number of plans that could operate in a given area, so that plans would have an incentive to bid aggressively in order to get into the market. Second, encourage competition by making it easy for participants to compare and select plans. Set and enforce quality standards so that seniors know that any eligible plan will provide at least a minimum level of benefit.

The third step is, once the Medicare Advantage market is up and running, begin to provide individuals with incentives to choose managed plans when they are a more efficient means of care. In some areas, especially sparsely populated ones, it may never be more efficient to run an HMO-style plan that traditional Medicare due to high administrative costs. In this case, people will choose to remain in the traditional plan. However, in more densely populated areas where efficient delivery networks can be assembled, managed plans may do a better job. Traditional Medicare would always remain an option, but to the extent that it is a more expensive method of delivering care than the managed plans, it would have a higher cost. This is not unlike the choices offered by many large employers (including the State of Illinois), where there are HMO options as well as more expensive “open network” options. Additional subsidies could also be offered to people who are poor or particularly sick.

In the end, we’ll end up somewhere a lot like where the Ryan plan is taking us – with traditional Medicare being replaced by managed care organizations as the predominant form of providing care to the elderly — with a couple of key differences. First, payments to plans will be set via competitive bidding to allow market forces to determine how much the government should be paying for health care rather than a pre-determined formula. Second, traditional Medicare will always remain as a backstop for those who are unable or unwilling to receive adequate care through the managed care system.

Certainly I haven’t said enough to establish whether this kind of plan could actually work or not. But what I like about it is that without the “radical change” that has Speaker Gingrich so rightly concerned. If it doesn’t work, we can always back off by lowering the price of traditional Medicare while we think about what happened and learn from our mistakes. The Ryan plan lacks such a safety valve. So, if we don’t get this huge policy change right the first time, there could be seriously bad consequences for years to come. And, that we are unlikely to get this right the first time is probably the one thing that everyone involved in the discussion will agree on.